12/05/2020

MONASH MONASH
BUSINESS BUSINESS
SCHOOL SCHOOL

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ACF5950 – Introductory Accounting
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Seminar 1: Introduction to Financial Accounting
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MONASH
BUSINESS What is Accounting?
SCHOOL

An information system or process that:

Learning Objectives
➢ identifies
▪ At the end of this lecture you should be able to: ➢ records
– Define and describe the basic purpose of financial accounting ➢ communicates
– Identify users of accounting information and the decisions they
make economic events of an entity to permit informed judgements and
– Introduce Accounting Standards and the Conceptual Framework decisions by interested users of the information.
– Explain the basic concepts of the four key financial statements and
describe their purpose
– Distinguish between accrual accounting and cash accounting
– Understand and apply the accounting equation using transaction
analysis

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What is Accounting? (continued) Why is Accounting Important?

The Accounting Process ➢ Accounting information conveys information about business

performance to others.

➢ Decisions are made based on the information provided.

➢ Poor accounting practices by businesses can produce

information that is inaccurate or misleading.

➢ This can lead to corporate collapses and financial ruin for many
people involved.

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The Role of Accounting Internal Users

➢ To assist users in making decisions about the allocation of Managers who plan, organise and run the business.
scarce resources.
Examples:

➢ Accounting measures business activity, and processes it into

➢ Chief Executive Officers (CEOs)
reports to enable communication of the information to users
who are internal or external to the entity. ➢ Marketing Managers
➢ Production Supervisors
➢ Chief Financial Officers (CFOs)

• Detailed and frequent information is needed by these

managers to make business decisions on a day-by-day basis.

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External users History of Regulation of Accounting

Vary in their nature and information requirements.
• Over time, Generally Accepted Accounting Principles (GAAP) were
developed to guide the practice of accounting.
Examples:
➢ Investors e.g., shareholders (use information to make decisions • As entities grew in size and complexity, more formal rules for accounting
to buy, hold or sell shares) were required.

• Today, ‘accounting standards’ are mandatory for many entities to follow in

➢ Creditors/Lenders e.g., suppliers, bankers (use information to the preparation of financial statements.
evaluate risks of giving credit and lending money)

➢ Government and regulatory bodies e.g., ATO, ASIC (use

information to determine an entity’s compliance with rules and
regulations)
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History of Regulation of Accounting What is the Conceptual Framework?

(continued)

• While these accounting standards provide ‘rules’ for dealing with

various accounting issues, there exists an underlying ‘conceptual • The conceptual framework can be considered the general principles
framework’ upon which the standards are developed. of financial reporting.
• This framework attempts to derive a theory for determining the
information to be provided in financial statements . • Think of it as the underlying set of concepts and theory that
underpins accounting.

HIERARCHY OF ACCOUNTING REGULATION • The conceptual framework is used as the basis for developing
specific accounting rules and regulations.
1. CONCEPTUAL FRAMEWORK
The theory!!!!!!
• It is a set of concepts which define the NATURE, SUBJECT and
CONTENT of accounting ”

2. ACCOUNTING STANDARDS • This will be taught in detail next week!!

The rules and principles!!!!!!!
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1. Statement of Accounting Concepts

2 Components - in Summary:
(SAC)1
Specifies which entities are
required to prepare financial
1. SAC 1 1a) Definition of the Reporting Entity statements!!!!!!

a) Definition of a ‘reporting entity’ WHO? • Defines a ‘Reporting Entity’ as any entity in which it is reasonable to
expect the existence of users who depend on general-purpose
financial statements for information to enable them to make
economic decisions.
2. The AASB Framework
a) The objective of general purpose financial reporting • If an entity meets this definition, it must prepare financial reports.
WHY?
b) The qualitative characteristics of information
c) the assumptions underlying financial reports
d) the five elements of accounting and the criteria for their
recognition
WHAT?
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2. The AASB Framework 2a) Objective of Financial Statements

The AASB Framework contains the following:

• The objective of general purpose financial reporting is to
a) Objective of financial reports provide financial information about the reporting entity that
b) Assumptions underlying financial reports is useful to existing and potential investors, lenders and other
c) Qualitative characteristics of financial reports creditors in making decisions about providing resources to
d) Elements of financial reports and their recognition criteria the entity.

TO PROVIDE USEFUL INFORMATION FOR DECISION MAKING!!!

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2b) Assumptions underlying Financial 2c) Qualitative Characteristics of Financial

Reports Reports
Qualitative characteristics are the attributes that make the information
provided in financial statements USEFUL to users
1. Going Concern
The characteristics are:
Entity assumed to continue indefinitely
Fundamental Characteristics
➢ Relevance
➢ Faithful representation (Reliability)

Enhancing Characteristics
➢ Comparability

➢ Verifiability
➢ Timeliness
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2d) Elements of Financial Statements General Purpose Financial Reports

The key financial statements are:

There are five elements of accounting:
– Balance Sheet (A,L and OE)
1. Assets Measures financial position at a point in time
2. Liabilities – Statement of Comprehensive Income / Income Statement (I,E)
3. Owner’s Equity Measures financial performance over a period of time
4. Income
– Statement of Cash Flows (the Asset Cash)
5. Expenses
Measures cash receipts and cash payments over a period of time

– Statement of Changes in Owners’ Equity (OE)

Presents a summary of changes that occurred in the entity’s
equity between two successive reporting dates

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Balance Sheet Assets

Assets are resources controlled by an entity that provide future
economic benefits, as a result of a past transaction.
▪ The Balance Sheet summarises the financial position of an
entity at a particular date
Assets can be categorised into current and non-current
• as at 30 June 2020 (in Australia)
– Current Assets
▪ An entity’s financial position is divided into 3 categories: ➢ Items converted to cash within one year
• Assets (A) (e.g., inventory)

• Liabilities (L)
➢ Items consumed within one year
• Owner’s Equity (OE) (e.g., office stationery)

– Non-current Assets
➢ Items intended to be held for longer than one year
(e.g., equipment, land and buildings, motor vehicles, long-term investments)
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Liabilities Owner’s Equity

Liabilities are present obligations resulting from a past transaction that
result in outflows of economic benefits. It is the owner’s investment in the entity
➢ It is the residual claim of the owners on the assets of the entity
Liabilities can be categorised into current and non-current ➢ It is measured as the excess of assets over liabilities
– Current Liabilities
➢ Obligations that are due to be repaid within one year
(e.g., creditors, bank overdraft, 6-month bank loan) OWNER’S EQUITY = ASSETS - LIABILITIES

– Non-current Liabilities OE = A - L
➢ Obligations that are due for repayment after one year
(e.g., 5-year loan, mortgage)

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Balance Sheet Example Income Statement

Monash Ltd
Balance Sheet
As at 30 June 2020
ASSETS ▪ Provides information on an entity’s profitability for a period of
Current Assets
Cash at bank 53,700
time
Accounts receivable 5,000 • E.g., for the period ended 30 June 2020
Non-current Assets
Equipment 4,500
Total Assets $63,200
▪ Measures the difference between:
LIABILITIES
Current Liabilities • Revenues earned during a period and Expenses incurred
Accounts Payable 5,000
Non-current Liabilities
in earning the revenues
Long-term loan 15,000
Total liabilities 20,000
• The difference is Profit if R > E
OWNER’S EQUITY • The difference is a Loss if R < E
Capital 30,000
Retained profits 13,200
Total owner’s equity 43,200 25 26
Total liabilities and owner’s equity $63,200

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Income Statement Example Additional Income Statement

Example
Monash Ltd Monash Ltd
Income Statement
Income Statement For the year ended 30 June 2020
For the period ended 30 June 2020 Sales revenue 21 000
LESS Cost of goods sold (8 000)
Service Revenue 50,000 Gross profit 13 000
less Expenses LESS Operating expenses
Salaries (2500)
Wages (15,600) Depreciation (500)
Advertising (10,800) Electricity (300)
Travel (300)
Total expenses (26,400)
Postage (400) (4000)
Profit 23,600 Profit before tax 9 000
LESS Income tax expense (3 000)
Profit after tax 6 000

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Statement of Comprehensive Income / Statement of Cash Flows

Income Statement
• Under Australian accounting standards (AASB 101 Presentation of ▪ Shows the changes in the cash account
Financial Statements) an entity can report income and expenses
as either: ▪ Shows cash receipts and cash payments for a period of time
• A single statement called Statement of Comprehensive
Income; or ▪ Cash transactions are split into 3 categories:
• Two separate statements called: ➢Operating activities (day-to-day operations)
– Income Statement (this is the focus in our subject); and ➢Investing activities (acquisition and disposal of non-
current assets)
– Statement of Other Comprehensive Income. It includes:
changes in revaluation surplus for fixed assets; fair value ➢Financing activities (financial structure)
changes in available for sale financial assets;
gains/losses from foreign operations. ▪ Considered in greater detail in Week 11

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Cash Flow Statement Example Statement of

Changes in Owner’s Equity
Monash Ltd
Statement of Cash Flows
For the year ended 30 June 2020
Cash flows from operating activities • This statement shows all changes to owner’s equity that
Receipts from customers 17 000 occurred during the period.
Payments to suppliers (7 700)
Payment to employees (2 300)
Cash operating costs (4 500)
Net cash flows from operating activities 2 500 • These changes could comprise
Cash flows from investing activities • capital
Purchase of machinery (2 300)
Net cash flows from investing activities (2 300) • profit
Cash flows from financing activities
Issue of shares 4 000
• drawings / dividends
Bank loan (3 600)
Net cash flows from financing activities 400
Total net cash flows 600
Cash: 1 July 2019 (opening balance) 1 400
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Statement of Changes in Cash and Accrual Accounting

Owner’s Equity (Example)
Monash Ltd • Entities need to record transactions and events that occur during a
Statement of Changes in Owner’s Equity period to enable them to prepare financial statements.
For the month ended June 30, 2020
• There are two methods of accounting that underlie the recording
Monash Ltd, capital, June 1, 2020 $10,000 process:
Owner ’s investment during the month 1,000
Profit for the month (I/S) 3,000 • Cash Accounting
14,000 • Accrual Accounting
Withdrawals during the month (2,000)
Monash Ltd, capital, June 30, 2020 (B/S) $12,000

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Cash versus Accrual Accounting Cash versus Accrual Accounting

• Accrual Accounting
• Cash Accounting
– Records revenues and expenses when transaction occurs
– Records revenues and expenses at the time the cash is
received or paid – Records income when i t has been earned (regardless of whether the
ca s h has been received).
– The cash flow may be in a different period to when the
– Records expenses when they have been i ncurred (regardless of
original transaction occurred whether the cash has been paid).
• For example, Company A made credit sales of $100,000
For example, Company A made credit sales of $100,000 i n June but the
in June but the cash was received in July after the ca s h was received i n July
financial year end (June 30)
• When is revenue recognised under accrual accounting?
• When is revenue recognised under cash accounting ?
JULY JUNE
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Cash versus Accrual Accounting The Accounting Equation

▪ Accrua l accounting also i ncludes non-cash expenses (depreciation; bad • The basic version of the accounting equation is:
a nd doubtful debts) which will be discussed in Weeks 5 a nd 6.

Assets = Liabilities + Owner ’s Equity

Cash Vs Accrual

• This equation expresses the relationship between the assets of the

entity and how the assets are financed (debt and/or equity).
▪ Accounting information for users is generally prepared using the
accrual basis ra ther than the cash basis of accounting

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The Accounting Equation (continued) Balancing the Accounting Equation

• If an entity has $960,000 worth of assets, and currently owes Assets = Liabilities + Owner ’s Equity
$400,000 for various liabilities, the accounting equation
determines that the owner’s equity must be:
• This equation must always stay balanced.
Assets = Liabilities + Owner’s Equity
$960,000 = $400,000 + ? • In order for this to occur, there needs to be a minimum ofTWO
effects.

Therefore Owner's Equity = $560,000

• When transactions are recorded in the accounting system, the
accounting equation maintains its balance at all times.

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Student Task Working – Student Task

For each item below, solve the accounting equation for the
missing figures:

a) Assets, $66,000; Liabilities, $32,000

b) Liabilities, $296,000; Owners’ equity, $364,000
c) Assets, $146,000; Owners’ equity, $75,000
d) Liabilities, $15,000; Owners’ equity, $42,000
e) Assets, $963,000; Liabilities, $432,000
f) Assets, $198,000; Owners’ equity, $126,000

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Transaction Analysis Transaction Analysis

The company purchases a $19,000 motor vehicle and funds it by

An owner provides $50,000 in cash funds to start the business borrowing using a bank loan

Assets = Liabilities + Owner’s Equity

Assets = Liabilities + Owner’s Equity
Cash Capital Motor Vehicle Bank Loan
$19,000 $19,000
$50,000 $50,000

• Thus increasing both assets (cash) and owners equity (capital). • This increases both assets (the vehicle) and liabilities (the bank
• Notice that both sides of the accounting equation increase, and it loan).
remains balanced.
• Again, both sides of the accounting equation increase, and it
remains balanced.

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Transaction Analysis Transaction Analysis

Changes do not always take place on both sides of the equation.
Some transactions cause decreases in the elements, such If cash was used to purchase a computer, one asset would
as a $3,500 part repayment of the loan principal (liability) Increase (computer) while the other decreases (cash).
with cash (asset).
Assets = Liabilities + Owner’s Assets = Liabilities + Owner’s Equity
Equity Computer
Cash Bank Loan $1,200
$3,500 $3,500 Cash
$1,200
Despite a reduction in both elements (assets and liabilities), the
equation once again remains in balance.
• The overall balances of the equation remain the same. It is only the
type of assets that have changed.

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Expanded Accounting Equation Extended Accounting Equation

Part 1 Part 1
• Revenue (Income) is shown as a positive addition to owner ’s equity,
• So far we have only considered transactions involving assets, since revenue contributes to profit.
liabilities and equity.

Assets = Liabilities + Owner ’s Equity + Income

• Transactions involving income and expenses must also be managed
by the accounting equation.
• Expenses are shown as a subtraction from owner ’s equity, since
expenses reduce profit.
• Since income less expenses equals profit (or loss), and profit (or
loss) relate to owner ’s equity, these last two elements can be
incorporated into the accounting equation. Assets = Liabilities + Owner ’s Equity + Income – Expenses

• We can now consider how transactions involving these two

elements can be analysed.

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Transaction Analysis Transaction Analysis

The recording of a $220 cash sale would increase assets (cash) If staff worked for an entity, but had not yet been paid, there
and increase revenue (sales). would be both an increase and decrease on the right hand side of
the equation.
Assets = Liabilities + Owner’s + Income - Expenses Assets = Liabilities + Owner’s + Income - Expenses
Equity Equity
Cash Sales Wages Wages
$220 $220 Payable Expense
$990 -$990

Here, both sides of the equation increase due to a rise in assets Despite owner ’s equity decreasing due to an expense, liabilities
and owner ’s equity increase causing no overall change in the balance of the
equation.
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Extended Accounting Equation Transaction Analysis

Part 2
• Addi tional capital is shown as a positive addition to owner’s equity. Let’s now consider an additional contribution of capital and its effect
on the equation.
As s ets = Li abilities + Owner’s Equity + Income – Expenses + Additional Capital

• Dra wings are shown as a subtraction from owner’s equity Assets = Liabilities + Owner’s + Income - Expenses + Additional – Drawings
Equity Capital
As s ets = Li abilities + Owner’s Equity + Income – Expenses + Additional Capital
– Dra wings
Cash Capital
• Thi s is the fully expanded accounting equation that we will be using. $50,000 $50,000

• We ca n now consider how transactions involving these additional elements

ca n be analysed. Both asset and owner ’s equity increase, and the equation remains
balanced.

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Transaction Analysis Reminder

This time, the owner takes cash drawings to spend on personal • Think of the accounting equation in its simplest form:
items. Drawings, the opposite to a contribution, result in a decrease
in owner ’s equity. Assets = Liabilities + Owner ’s Equity

Assets = Liabilities + Owner’s + Income - Expenses + Additional - Drawings • Income and additional contributions of capital increase owner ’s
Equity Capital equity, so should be added.
+ Income + Additional Capital
Cash Drawings
$5,000 -$5,000
• Expenses and owner ’s drawings decrease owner ’s equity, so should
be subtracted.
- Expenses - Drawings
Both equity and assets decrease thus the equation is still in
balance.

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MONASH
BUSINESS
SCHOOL

Learning Objectives
Group Work Task ▪ At the end of this lecture you should be able to:
– Describe the basic purpose of financial accounting
– Identify users of accounting information and the decisions
they make
– Introduce Accounting Standards and the Conceptual
Framework
– Explain the basic concepts of the four key financial
statements and describe their purpose
– Distinguish between accrual accounting and cash accounting
– Understand and apply the accounting equation using
transaction analysis

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